The IMF Has "a long history of stabilizing economies and solving global financial problems"?

Saturday, 24 April 2010 06:01

That's what the Washington Post told readers this morning. This claim would news to hundreds of millions of people around the developing world. Back in the 90s the IMF came to be known as the "Typhoid Mary" of emerging markets as its policy prescriptions led to sharp economic downturns in one country after another. It tried to impose a harsh austerity plan on Argentina in 2001 and did everything it could to sabotage its economy when the country refused to go along. Its sabotage effort included economic growth projections that were likely politically motivated, since they consistently under-projected growth. This would have the effect of scaring away potential efforts. By contrast, the IMF consistently over-projected Argentina's growth in the years when it was following policies recommended by the IMF.

The theme of the article is that people in wealthy countries will have to accept lower living standards, as indicated by its headline: "for nations living good life, the party is over, IMF says." Of course, nations don't live the good life, individuals within nations do. In the United States, and to a lesser extent, most other wealthy countries, the last three decades have been marked by an upward redistribution of income. This has led to a situation in which most of the gains from growth have gone to those at the top end of the income distribution. This would suggest policies that focused on cutting back on their good life, for example a financial transaction tax or the financial activities tax (FAT) that was proposed by the IMF last week. This would cutback on the high incomes of Wall Street's "top performers" while leaving most of the rest of the country largely unaffected.

The distributional issue is also important in the context of one of the other policies highlighted by the IMF: reducing the value of the dollar against the yuan and other currencies. This will raise the price of imports and in that way lower living standards in aggregate. However, by making U.S. manufacturing more competitive, it will increase the demand for manufacturing workers, allowing many workers without college degrees to get relatively high-paying jobs. This is likely to lead to an improvement in living standards even if these workers have to pay somewhat more for imported goods. (Imagine a worker can get paid $20 in auto factory instead of $10 working in a convenience store. They will be much better off even if they have topay 20 percent more for their clothes, shoes, and toys.)

Finally, this article includes an assertion that the United States might need: "roughly $1.4 trillion annually, to be cut from government programs or raised through new taxes." There is no remotely plausible story that would give a number even half this large. This is the size of the government's current budget deficit. More than half of this shortfall is attributable to the fact that the economy is operating well below full employment. If the country were at normal levels of output, the current deficit would be less than 5 percent of GDP.

And, there is no reason that the country must balance its budget. Deficits equal to 2-3 percent of GDP are consistent with a stable or declining debt to GDP ratio. This means that the adjustment needed to get the budget on a stable fiscal footing are likely less than one-quarter of what is implied by this Post article. Furthermore, much of this gap can be made up simply by allowing freer trade in medical services.